Abstract
ABSTRACTWe provide empirical evidence of the relationship between downward wage rigidity and unemployment volatility by comparing wage dynamics and worker mobility during the Great Recession in two countries where wages adjusted very differently: Latvia and Spain. Using a panel of social security administrative data, we find that wages in Spain were rigid even during periods of rising unemployment. In contrast, Latvian wages were reduced and wage cuts affected 60 percent of jobs. At the same time, the elasticity of workers' transition rates into and out of unemployment to productivity shocks was four times higher in Spain than in Latvia, and these responses were more persistent in Spain. This evidence is consistent with theoretical models that show that unemployment volatility is higher when wages are rigid.
Highlights
Wage rigidity tends to amplify any shock to the labour market
Latvia and Spain are different in terms of population size and economic development (in 2007, the size of the population was 20 times higher and the GDP per capita (PPP) was 1.7 times higher in Spain), we focus on the striking similarities in the two countries’ experience during the Great Recession
We extend the typical analysis of wage rigidity, which usually focuses on stayers, and analyze wage dynamics for workers that switch jobs
Summary
Wage rigidity tends to amplify any shock to the labour market. A fall in real wages ameliorates the decline in employment, whereas if wages were to be rigid, any transitory shock to the market would lead to a persistent decline in employment, capital and consumption, generating a jobless recovery (Shimer, 2012b). The importance of wage rigidity is even more apparent in countries with fixed exchange rate arrangements (Schmitt-Grohe & Uribe, 2011). Given its importance from many points of view and its widespread presence in different economies, wage rigidity has been extensively analyzed, both theoretically and empirically. The empirical literature has measured the incidence of wage rigidity in different ways, mainly focusing on the distribution of wage changes in the same job to show that there are few wage cuts (Altonji & Devereux, 1999; Goette, Sunde, & Bauer, 2007; Gottschalk, 2005). There is evidence of prevalent resistance to wage cuts, both in nominal and real terms, and both in developed and developing countries.
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